Private lenders’ demand for audit



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Baylis, R. M., et al. (2017). "Private lenders’ demand for audit." Journal of Accounting and Economics 64(1): 78-97.

We study clauses in private lending agreements requiring auditors to assure lenders of borrowers’ compliance with financial covenants. Auditors are required under general purpose financial reporting to review covenant compliance. However, by informing lenders directly that they have no knowledge of default, auditors may increase their litigation risk. We find that auditor covenant compliance assurance clauses are significantly associated with more complex contractual adjustments to net income, the extent of reliance on accounting information in the contract, intangibility of borrowers’ assets, the number of lenders and loan maturity. We provide novel evidence of the audit market enhancing efficient contracting.


Call, A. C., et al. (2017). "Employee quality and financial reporting outcomes." Journal of Accounting and Economics 64(1): 123-149.

We examine the association between employee quality and financial reporting outcomes. Using the average workforce education level in MSA(s) where the firm operates as a proxy for employee quality, we find that firms with a high-quality workforce exhibit higher accruals quality, fewer internal control violations, and fewer restatements. These firms also issue superior management forecasts, in terms of frequency, timeliness, accuracy, precision, and bias. Employees located at the firm's headquarters primarily drive our findings. Our evidence suggests employee quality, particularly at a firm's headquarters, is associated with both mandatory and voluntary disclosure quality.


Chen, Q. and R. Vashishtha (2017). "The effects of bank mergers on corporate information disclosure." Journal of Accounting and Economics 64(1): 56-77.

Applying a difference-in-differences approach to explore variations in the timing of bank mergers in the U.S. over the last two decades, we document an increase in borrowers’ disclosure when their banks engage in mergers and acquisitions. The effect is stronger among borrowers more reliant on services from the merging banks and when mergers cause larger changes in banks’ monitoring and financing of borrowers. These findings suggest an information spillover effect from bank mergers to the public financial markets, and have implications for how changes in banking markets affect the availability of public disclosure in the stock markets.


Fung, S. Y. K., et al. (2017). "Does the PCAOB international inspection program improve audit quality for non-US-listed foreign clients?" Journal of Accounting and Economics 64(1): 15-36.

We examine whether the Public Company Accounting Oversight Board (PCAOB) international inspection program improves audit quality for a sample of non-US-listed foreign public client companies from 55 countries audited by foreign (i.e., non-US) auditors. For a sample of non-US-listed clients of PCAOB-registered foreign auditors, we find that initial PCAOB inspections improve audit quality, over and above the threat of such inspections, for foreign auditors’ non-US-listed foreign clients. Our findings document the benefits of PCAOB international inspections for foreign investors in non-US-listed foreign companies which could increase the acceptability of the PCAOB international inspection program abroad.


Heese, J., et al. (2017). "Is the SEC captured? Evidence from comment-letter reviews." Journal of Accounting and Economics 64(1): 98-122.

SEC oversight of publicly listed firms ranges from comment letter (CL) reviews of firms’ reporting compliance to pursuing enforcement actions against violators. Prior literature finds that firm political connections (PC) negatively predict enforcement actions, inferring SEC capture. We present new evidence that firm PC positively predict CL reviews and substantive characteristics of such reviews, including the number of issues evaluated and the seniority of SEC staff involved. These results, robust to identification concerns, are inconsistent with SEC capture and indicate a more nuanced relation between firm PC and SEC oversight than previously suggested.


Marinovic, I. and P. Povel (2017). "Competition for talent under performance manipulation." Journal of Accounting and Economics 64(1): 1-14.

We study the effects of introducing competition for CEOs, assuming that the talent of CEOs is not observable and that they can misreport their performance. Without competition for talent, firms maximize their profits by offering inefficiently low-powered incentive contracts. Competition for talent removes those inefficiencies, but it leads to excessively high-powered incentive contracts, causing efficiency losses that can be more severe than the inefficiencies that competition mitigates. If misreporting is not a concern, however, then competition for talent has unambiguously positive effects on efficiency.


Srivastav, A., et al. (2017). "CEO turnover in large banks: Does tail risk matter?" Journal of Accounting and Economics 64(1): 37-55.

In a cross-country setting we show the probability of a forced CEO turnover in large banks is positively associated with idiosyncratic tail risk. This finding is strengthened the greater the competition in the banking industry and when stakeholders have more to lose in the case of distress. Overall, the exposure to idiosyncratic tail risk offers valuable signals to bank boards on the quality of the choices made by CEOs. In contrast, systematic tail risk becomes important for forced CEO turnovers only in the presence of a major variation in the costs this risk generates for shareholders and the organization.


Andries, K., et al. “The effect of corporate taxation on bank transparency: Evidence from loan loss provisions.” Journal of Accounting and Economics 63 (2–3): 307-328.

We examine how the corporate tax system, through its treatment of loan losses, affects bank financial reporting. Exploiting cross-country and intertemporal variation in income tax rates and loan loss provision deductibility, we find that loan loss provisions are increasing in the tax rate for countries that permit general provision tax deductibility. When general provisions are deductible, a 1 percentage point rate increase leads to a provision increase of 4.9% of the sample average. This effect is driven by the tax system's encouragement of timelier loan loss recognition, suggesting that corporate taxation is an important determinant of bank financial reporting transparency.


Aobdia, D. and Shroff, N. (2017). “Regulatory oversight and auditor market share.” Journal of Accounting and Economics 63 (2–3): 262-287.

We examine whether auditor regulatory oversight affects the value of financial statement audits. Using the PCAOB international inspection program as a setting to generate within country variation in regulatory oversight, we find that non-U.S. auditors inspected by the PCAOB gain 4% to 6% market share from competing auditors after PCAOB inspection reports are made public. When inspection findings reveal that an auditor has many engagement-level deficiencies, market share gains following inspection reports are significantly smaller. Our evidence suggests that regulatory scrutiny increases the assurance value of an audit and highlights the role of public regulatory oversight in the audit market.


Bonsall IV, S. B., et al. (2017). “A plain English measure of financial reporting readability." Journal of Accounting and Economics 63 (2–3): 329-357.

We propose a new measure of readability, the Bog Index, which captures the plain English attributes of disclosure (e.g., active voice, fewer hidden verbs, etc.). We validate this measure using a series of controlled experiments and an archival-based regulatory intervention to prospectus filing readability. We also demonstrate the importance of understanding the underlying drivers of quantity-based measures of readability. In particular, we caution researchers that a vast amount of the variation in Form 10-K file size over time is driven by the inclusion of content unrelated to the underlying text in the 10-K (e.g., HTML, XML, PDFs).


Dou, Y. (2017). “Leaving before bad times: Does the labor market penalize preemptive director resignations?” Journal of Accounting and Economics 63 (2–3): 161-178.

When firms experience negative events such as lawsuits or earnings restatements, their directors also suffer. But what about those who leave shortly before the events? I show that directors who leave prior to negative events experience greater declines in the number of their directorships than directors who stay through the events, but smaller declines than directors who leave after the events. These declines do not appear to be voluntary or driven by forced departures. Instead, they appear to be the results of labor market penalties. The results suggest that resigning pre-emptively does not protect directors from labor market penalties.


Akins, B., Dou, Y., & Ng, J. (2017). Corruption in bank lending: The role of timely loan loss recognition. Journal of Accounting and Economics63(2-3), 454-478.

Building on the recent literature on corruption in bank lending, we examine the effect of country-level timely loan loss recognition by banks on lending corruption using a unique World Bank dataset that covers more than 3,600 firms across 44 countries. We find evidence consistent with timely loan loss recognition constraining lending corruption because it increases the likelihood of problem loans being uncovered earlier. In further analysis, we find timely loan loss recognition to be less associated with reduced corruption in countries where there is significant government ownership in the banking system and deposit insurance schemes. This evidence is consistent with timely loan loss recognition being less of a deterrent to lending corruption when banks are less disciplined by their capital providers.



Bradley, D., et al. (2017). “Are all analysts created equal? Industry expertise and monitoring effectiveness of financial analysts?” Journal of Accounting and Economics 63 (2–3): 179-206.

We examine whether analysts’ prior industry experience influences their ability to serve as effective external firm monitors. Our analyses of firms’ financial disclosure quality, executive compensation and CEO turnover decisions portray a consistent picture that related pre-analyst industry experience is of critical importance for analysts to play an effective monitoring role. Coverage by analysts with such experience is associated with reduced earnings management, lower probability of committing financial misrepresentation, less CEO excess compensation, and higher performance sensitivity of CEO turnover. We also provide evidence on several plausible mechanisms through which industry expert analysts exert monitoring efforts and limit managerial opportunism.



Ge, W., Koester, A., & McVay, S. (2017). Benefits and costs of Sarbanes-Oxley Section 404 (b) exemption: Evidence from small firms’ internal control disclosures. Journal of Accounting and Economics63(2-3), 358-384.

We quantify measurable benefits and costs of exempting firms from auditor oversight of internal control effectiveness disclosures. We measure the benefit of exemption as an aggregate $388 million in audit fee savings from 2007–2014. The costs stem from internal control misreporting: an aggregate $719 million of lower operating performance due to non-remediation and a $935 million delay in aggregate market value decline due to the failure to disclose ineffective internal controls. The audit fee savings benefit shareholders of all exempt firms, whereas the costs are borne by shareholders of only a fraction of exempt firms (the internal control misreporters).


Hope, O. K., Hu, D., & Zhao, W. (2017). Third-party consequences of short-selling threats: The case of auditor behavior. Journal of Accounting and Economics63(2-3), 479-498.

This study examines how short-selling threats affect auditors. During 2005–2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index firms were arbitrarily chosen to be exempted from short-sale price tests. As a result, these stocks faced significantly higher short-selling threats. We implement a difference-in-differences test with firm fixed effects to show that auditors react to the increased threats and charge higher audit fees to the pilot firms. Further, we find that the impact only exists when auditors are concerned with the bankruptcy risk or when managers are less likely disciplined by short sellers.



Horton, J. (2017). “Career concerns of banking analysts.” Journal of Accounting and Economics 63 (2–3): 231-252.

We study how career concerns influence banking analysts’ forecasts. Banking analysts’ first (last) earnings forecast of the year is relatively more optimistic (pessimistic) for a bank that could be their future employer. This pattern is not observed when the same analysts forecast earnings of banks unlikely to be their future employer. We use the Global Settlement as an exogenous shock on career concerns and show that this forecast pattern is more pronounced after the Settlement. Moreover, we find evidence that analysts benefit from this behavior as analysts that are more biased in their forecasts of potential future employers are more likely to move to a higher reputation bank.



Iselin, M., & Nicoletti, A. (2017). The effects of SFAS 157 disclosures on investment decisions. Journal of Accounting and Economics63(2-3), 404-427.

This paper examines whether public bank managers change both the composition and classification of their investment portfolios after SFAS 157. We first show that non-agency mortgage-backed securities (MBSNA) are the asset class most likely to be measured using level 3 inputs, which are based on unobservable information. We then find that relative to a control sample of private banks, public banks altered their investment portfolios in a manner that reduced the percentage of MBSNA holdings for which SFAS 157 disclosures are required. Taken together, this evidence is consistent with public banks attempting to avoid disclosure of level 3 assets through changes in both asset composition and classification.



Jiang, X., & Yang, M. (2017). Properties of optimal accounting rules in a signaling game. Journal of Accounting and Economics63(2-3), 499-512.

We characterize the properties of optimal accounting rules in a signaling game. An impatient firm sells shares to competitive investors. The firm can signal its private information about the fundamental by retaining a fraction of the shares. In addition, the firm can commit to disclosing information according to a set of accounting rules chosen ex ante. Information disclosure reduces signaling cost so that perfect disclosure is optimal. When perfect disclosure is impossible, the optimal accounting rule features a lower bound and a summary statistic of the fundamental. The interpretation of the lower bound is consistent with accounting conservatism, and the statistic summarizes the information most relevant to the firm׳s valuation. The justification for accounting conservatism relies on the existence of information asymmetry and the infeasibility of perfect accounting disclosure. This is consistent with the conjecture of LaFond and Watts (2008) that information asymmetry calls for accounting conservatism.



Jongjaroenkamol, P. & Laux, V. (2017). “Insider versus outsider CEOs, executive compensation, and accounting manipulation.” Journal of Accounting and Economics 63 (2–3): 253-261.

This paper examines the role of the financial reporting environment in selecting a new CEO from within versus outside the organization. Weak reporting controls allow the CEO to misreport performance information, which reduces the board's ability to detect and replace poorly-performing CEOs as well as aggravates incentive contracting. We show that these adverse effects are stronger when the CEO is an outsider rather than an insider. Our model predicts that boards are more likely to recruit a CEO from the outside when the performance measures with which the new hire is assessed are harder to manipulate.


Kim, J., et al. (2017). “Languages and earnings management.” Journal of Accounting and Economics 63 (2–3): 288-306.

We predict that managers of firms in countries where languages do not require speakers to grammatically mark future events perceive future consequences of earnings management to be more imminent, and therefore they are less likely to engage in earnings management. Using data from 38 countries, we find that accrual-based earnings management and real earnings management are less prevalent where there is weaker time disassociation in the language. Our study is the first to examine the relation between the grammatical structure of languages and financial reporting characteristics, and it extends the literature on the effect of informal institutions on corporate actions.


Kubick, T. R., Lockhart, G. B., Mills, L. F., & Robinson, J. R. (2017). IRS and corporate taxpayer effects of geographic proximity. Journal of Accounting and Economics63(2-3), 428-453.

We investigate whether geographic proximity between corporate headquarters and IRS regional offices affects corporate tax avoidance and the likelihood and productivity of IRS examinations. Using geographic distance to represent information asymmetry, we find that corporations avoid more tax when located closer to the IRS unless they are close to an IRS industry specialist. This finding is consistent with taxpayers believing proximity provides them with an information advantage over the IRS. From the perspective of the IRS, we find that the Service is more likely to audit nearby companies and to assess more tax per hour from nearby taxpayers, except during constrained budget years. IRS audit likelihood and productivity are unaffected by the presence of nearby industry specialists, consistent with industry specialist proximity already constraining avoidance. Our tax compliance setting provides dual-party evidence on the proximity-information asymmetry hypothesis.



Kumar, P., et al. (2017). “Voluntary disclosure and strategic stock repurchases.” Journal of Accounting and Economics 63 (2–3): 207-230.

We study the choice of disclosure and share repurchase strategies of informed managers using a model that captures how they differentially impact short and long-term stock value. We identify a partial disclosure equilibrium in which firms in the lowest value region neither disclose nor repurchase, firms with intermediate values disclose but do not repurchase, and firms in the highest value region induce undervaluation by not disclosing and buy back shares. In particular, the well-known unraveling result when the manager is always informed (and when disclosure is costless)—the typical upper-tailed disclosure region in classic voluntary disclosure models—need not obtain when informed managers can use repurchases to extract information rents. We offer a new perspective on open-market share repurchases—the most common form of share repurchases—when chosen optimally with disclosure. Our analysis indicates that the equilibrium disclosure region shrinks as the firm's stock trading liquidity increases.



Levy, H., & Shalev, R. (2017). Bond repurchase objectives and the repurchase method choice. Journal of Accounting and Economics63(2-3), 385-403.

This study investigates how firm׳s bond repurchase objective affects its choice of repurchase method. Unlike tender offers, open-market repurchases are not pre-announced and buyer׳s identity is unknown to the seller. We provide evidence that firms are likely to repurchase on the open-market when bonds are mispriced and when firms seek to manage their financial reports, either to meet earnings targets or avert debt covenant violations. When firms seek to amend indenture terms, they prefer tender offers. We also find that firm׳s information quality affects the likelihood of mispricing exploitation behavior and that insiders buy firm׳s stocks around open-market repurchases.


Badia, M., et al. (2017). "Conditionally conservative fair value measurements." Journal of Accounting and Economics 63(1): 75-98.

Firms measure fair values using Level 2 or 3 inputs when items do not trade in liquid markets, limiting market discipline over the measurements. We provide evidence that firms holding higher proportions of financial instruments measured at Level 2 and 3 fair values report more conditionally conservative comprehensive income attributable to fair value measurements, consistent with firms trying to mitigate investors' discounting of the measurements. We further predict and find that this conditional conservatism (1) increases with governance mechanisms that increase the strength and persistence of firms' incentives to report conservatively and (2) decreases with firms’ earnings management incentives.


Bhojraj, S., et al. (2017). "Takeover defenses: Entrenchment and efficiency." Journal of Accounting and Economics 63(1): 142-160.

This paper explores the potential role of anti-takeover provisions (ATPs) in long-term value creation. Using a change in the legal environment in Delaware as an exogenous event, we document that a subset of firms with a relatively longer term focus (innovative firms) benefit from ATPs. Particularly, these firms experience an increase in Tobin's Q following a state law change in Delaware that increases the effectiveness of ATPs in defending against hostile takeovers. This increase is greater than that for non-innovative firms in Delaware as well as for innovative firms outside Delaware. Furthermore, the innovative firms in Delaware experience a stronger positive market reaction around the state law change dates, relative to other firms. Finally, in a cross-sectional setting we find that innovative firms with above-average takeover protection outperform other firms and are less likely to engage in harmful real earnings management. Taken together, these results provide empirical evidence of potential benefits of ATPs and help explain why such protection continues to be prevalent in the United States.


Caskey, J. and N. B. Ozel (2017). "Earnings expectations and employee safety." Journal of Accounting and Economics 63(1): 121-141.

We examine the relation between workplace safety and managers’ attempts to meet earnings expectations. Using establishment-level data on workplace safety from the Occupational Safety and Health Administration, we document significantly higher injury/illness rates in firms that meet or just beat analyst forecasts compared to firms that miss or comfortably beat analyst forecasts. The higher injury/illness rates in firms that meet or just beat analyst forecasts are associated with both increases in employee workloads and in abnormal reductions of discretionary expenses. The relation between benchmark beating and workplace safety is stronger when there is less union presence, when workers’ compensation premiums are less sensitive to injury claims, and among firms with less government business. Our findings highlight a specific consequence of managers’ attempts to meet earnings expectations through real activities management.


Dimitrova, L. (2017). "Perverse incentives of special purpose acquisition companies, the “poor man's private equity funds”." Journal of Accounting and Economics 63(1): 99-120.

Special purpose acquisition companies (SPACs) are an alternative investment, structured as a one-shot private equity (PE) deal. Significant cross-sectional variation exists in SPACs' performance, which can be explained by the strong implicit incentives embedded in contracts. SPAC performance is worse for acquisitions announced near the predetermined two-year deadline, for acquisitions with deferred initial public offering underwriting fees, and for acquisitions with market value close to the required 80% threshold. Also, sponsors' involvement in the merged firm's governance improves long-term performance. This evidence has important implications given SPACs' high popularity in recent years and the new PE industry's trend toward deal-by-deal fund-raising.



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